by Guy Lawson
For Dan Marino, faking the audit was crossing multiple boundaries, legal and professional. The deceit ran contrary to Marino’s most basic ethical obligations as an accountant. But Marino didn’t hesitate, either. He had only one demand. He wanted Israel and Marquez to sign a document stating that the false audit was their idea and then videotape confessions saying that they’d asked Marino to perpetrate the fraud. The letter and video would be Marino’s proof that he was the lesser conspirator. Marquez was the lead trader at Bayou; Sam was the owner. Marino wanted it clear to the authorities, should the day ever come, that he was only a functionary.
“What are you talking about?” Israel said to Marino. “That’s insane. I’m not doing that.”
“You both should do it,” Marino said. “This is both your faults.”
“Go fuck yourself,” Israel said.
“Go fuck yourself,” Marquez added.
“Let me put it to you this way, Dan,” Israel said. “We could put the right number in the audit and you’re out of a job. You have nowhere to go because you work for Jimmy and Jimmy’s got nowhere to go. I have somewhere to go. I can pick up this phone right now and dial Lee Cooperman. He’ll say I can start tomorrow. You don’t have that, Dan, and you don’t have that, Jimmy. So you can both go fuck yourselves if you think I’m going to make a videotape.”
The subject was dropped. Mutually assured destruction was what they were left with.
Marino would create a false audit. None of them would breathe a word of what they were doing. No spouses or siblings or drinking buddies. No con"dants. Marino would tend to the technical details. Israel and Marquez would come up with the performance numbers—fake returns that matched what they’d already been telling Bayou’s members in phone calls and e-mails.
In Marino’s mind there would now be two sets of books. There would be “Performance: Actual” and “Performance: Published.” Marino would keep track of both to ensure they were able to pay the right amount when Sam and Jimmy "nally traded them out of the hole. For Marino, the "rst step was to sprinkle the magic powder of commission rebates over the returns. The money generated by Bayou Securities was passed back to Bayou Funds, adding 12 percent to the performance numbers. The sleight of hand was literally robbing Bayou Securities to pay Bayou Funds, but that kind of deception was minuscule compared to what came next.
“I decided to set up a fake accounting "rm to do the audit,” Marino recalled. “The "rst thing I did was come up with a name for the "rm. I went with Richmond-Fair"eld.
I liked the concept of a company that covered a geographical area—in this case Richmond County on Staten Island, where I lived, and Fair"eld County, where Bayou’s o$ces were located. It sounded cool to me. After that I came up with the stationery design and obtained approval from Jimmy and Sam on that. Then I set up the checking accounts. I made sure they were part of it all.
“Next I made arrangements with someone to use desk space at their o$ce in Manhattan. In a way, I told them the truth. I was setting up my own accounting "rm and needed some space to work, as well as a phone and a fax. Part of Richmond-Fair"eld was a backup plan for me. If Bayou failed quickly, or if it succeeded and they kicked me out anyway, I had a "rm that maybe I could build up for myself. Then I did the audit. That part was really simple. Bayou was a plain vanilla trading "rm. The fund traded and didn’t take long-term positions. Since the fund was small, no auditor would rely on internal controls to do the audit. An auditor would do what is called substantive testing of the trades to verify the transactions and make sure they are recorded properly. But I didn’t have to do the work, of course.
“The interesting part, to me at least, was how easy it would have been to put my name together with the auditor. All you had to do was google ‘Richmond-Fair"eld’ and my name would come up. The fake "rm was registered with the New York State Accounting Society. If anyone had gone to the o$ce I sublet, they would have seen my personal name in the directory. Any minor but persistent due diligence would have discovered my link to Richmond-Fair"eld immediately. Why no one did it is simply beyond me to explain. I would have done it.”
TO CREATE THE ACTUAL AUDIT document, Marino copied verbatim the format Grant Thornton had used the previous year. On the one-page “Statement of Financial Condition for December 31, 1997,” Bayou’s assets had been listed as follows: Cash
$1,526
Securities Owned
$1,587,936
Due from Brokers
$3,105
Prepaid Expenses
$4,000
Organization Expenses
$32,504
Total Assets
$1,629,071
The audit for 1998 by Richmond-Fair"eld had an identical format, with higher numbers to reflect Bayou’s growth:
Cash
$526
Securities Owned
$351,750
Due from Brokers
$3,761,539
Prepaid Expenses
$5,000
Organization Expenses
$22,505
Total Assets
$4,141,320
The biggest di!erence in amounts was in the line “Due from Brokers.” The sum had jumped from just $3,000 in 1997 to nearly $4,000,000 in 1998. Because Bayou had attracted a lot of investment for the year and total assets had increased at a rapid rate, the huge increase made sense—provided no one asked what “Due from Brokers”
actually meant. In 1997, it had meant the sum of money that Bayou had on deposit with its clearinghouse; Bayou maintained an account, so the nominal sum was a real asset. In 1998, the total of $3,761,539 was a "ction. The cheat was there on the page for all to see—at the same time as it was invisible. Marino knew that people’s eyes glazed over when confronted with columns of numbers. Inevitably, attention fell to the bottom line. “Due from Brokers” simply meant the amount that happened to be in the account Bayou maintained with its clearinghouse, Spear, Leeds & Kellogg—a highly reputable "rm that performed the execution of the fund’s trades. Who would question such a simple change?
“I didn’t discuss this with Jimmy and Sam,” Marino said. “I just told them that it was the best place to hide it because we didn’t have to make up any positions in stocks that could cause an issue in the future. It was just cash sitting with our clearinghouse in an account under Bayou’s name. Money was either ‘owed to’ or ‘due from’ the broker. The fact that it was cash dovetailed with the way Jimmy and Sam were marketing the fund.
Going to cash at the end of the day or week or month was a way to manage risk. We told our investors that we got out of our positions, especially at the end of the year.
That was the time of year when there were a lot of antics to try to window-dress performance, or lower taxes.
“If the investors were smart enough to truly look at the "nancial statement of Bayou Funds, they would’ve asked me for an explanation. No one asked. If they did ask, I would’ve said we had two accounts with the clearinghouse because we don’t want them to know all the trades we do. The regulators could’ve looked at the audit and asked for statements when they were looking at Bayou Securities. The regulators should’ve known that when they inspected Bayou Securities they were actually seeing all the trading transactions of the hedge fund. They could’ve looked through the broker-dealer to see how the fund was doing—and see that it was losing money.
“You could say it was elementary, or you could say it was sophisticated. The bottom line is that it worked. No one looked. Ever. It was an example of the soft underbelly of the business. There are many soft underbellies in the hedge fund business that can be exploited—and that’s what we did.”
THE YEAR BEFORE, the wait for the audit had made some investors uneasy. This year the audit was ready right on time—in fact slightly early. On March 23, Israel wrote to Bayou’s members, enclosing the annual audited report. “In order to provide all members with timely information, we have made the decision to switch our auditors from Grant Thornton
to a smaller "rm named Richmond-Fair"eld Associates,” Israel wrote. He said the change avoided paying Grant Thornton’s exorbitant fee, underlining Bayou’s thrifty ways. “We have found that being a larger "sh in a smaller, high quality pond is more advisable for us at this time.”
Attached was a cover letter from Richmond-Fair"eld. The logo for the "rm Marino had invented was a small teardrop. The address given was 111 John Street, the building near Wall Street where Marino had sublet space. “In our opinion the "nancial statements present fairly, in all material respects, the "nancial position of Bayou Funds,” the auditors wrote.
The adjusted gross rate of return for Bayou was 22.047 percent. The year before it had been 40.92 percent (a concoction of Marino’s commission rebate). The tiny fund was developing an outstanding record. The market had boomed in 1998, but there had been considerable volatility as well. Israel and Marquez reasoned that it was okay to not claim to have beaten the bull. The numbers had to attract attention—but only the right kind. According to the audit, gross income was $519,314, less the 20 percent management fee paid to the managers—which amounted to $103,862.80. The net pro"t to members was $415,452. To the unpracticed eye looking over Bayou’s "nancials, the fund was promising, intriguing even, not one of the #ash-in-the-pan funds that had one or two excellent years and then collapsed. But Bayou’s performance didn’t portray Israel as one of the leading men of Wall Street—not yet.
Israel and Marquez set about trying to attract the money they all believed was needed to turn Bayou around. Third-party marketers were engaged to sell the fund to high–net worth individuals. The fake audit proved a great marketing tool. Bayou’s story was getting easier to tell all the time. Marquez picked stocks. Sam ran the computer program. Bayou was neither a value investor nor a purely technical buy/sell fund. It was both. The hybrid was a thoroughbred.
“Obviously, I was lying and cheating,” Sam said. “But in my life I was not a liar and a cheater. I was doing things that just weren’t like me. It was like it wasn’t even me who was doing all the cheating and lying.”
The money started to #ow in. The sums weren’t huge. But hits of $50,000 and $100,000 added up. Bayou soon crossed the $5 million threshold, another encouraging milestone. The move to the boathouse had energized Marquez. Prone to upswings in energy, inevitably followed by depressive downswings, Marquez arrived at work before dawn and scoured trade publications for leads. Internet stocks were the rage on Wall Street. But Marquez was interested in less fashionable industries, like oil and coal.
While fortunes were being made on Internet stocks, Marquez shunned the herd. Big thoughts were his forte. The kind of trading that Sam did at Bayou was beneath Marquez’s dignity, he told Marino. Marquez had theories about the economy and society—about life—that were consequential and would yield the pro"ts Bayou so desperately needed.
But Marquez’s positions turned out to be nearly uniformly awful. Marquez was becoming borderline irrational, it seemed to Sam. Longshot long bets had to be sustained against the day the market caught up with Marquez—if it ever did. But Bayou needed to make money immediately. There was no time to wait for Marquez’s airy theories to be proven correct. The arguments were becoming bitter and personal—screaming matches in the trading room upstairs at the boathouse.
As Internet stocks soared, no matter the underlying value of the company, Sam could see that the Federal Reserve was pumping liquidity into the stock market, as if the only social good were rising industrial averages, regardless of the cost. In his own deceptions, Sam saw the deception of a market arti"cially in#ated by speculation. The way he looked at it, the entire market was doing what he was doing, only on such a massive scale it was impossible to see the monstrosity.
“With the Internet boom, people weren’t trading and promoting real companies anymore,” Israel recalled. “It used to be General Motors and Procter & Gamble employed millions of Americans. Now there was eBay, which had a card table in a room with four chairs and a computer screen. So many of the companies coming onto the market were nothing. You could pass your hand through them—there was nothing to them. All my life I’d cheered for people to get ahead. I wanted these Internet scumbags to lose. It killed me.”
As pressures mounted, Sam found oblivion in booze and cocaine, becoming a functional alcoholic, by his own reckoning. His desire to not think about his woes found a healthy outlet as well, as he started to train like a maniac for a triathlon. Seeking the endorphin rush of extreme exercise, Sam ran and biked and swam in every spare moment. In the spring, Sam traveled to Florida to compete in the Tinman Triathlon in Pensacola. After he completed the grueling event, Israel decided to celebrate by getting a tattoo on his hip. The design he chose was “Little Devil,” the small red cartoon character cherub with a crooked grin carrying a trident—the secret manifestation of his new reality.
FOR MONTHS Dan Marino had been plagued by a dry cough. When X-rays and repeated doctor visits failed to "nd a diagnosis, Marino treated it like a bad cold, or chest infection, and continued to work. But then night chills began, and Marino lay in bed drenched in sweat and shivering. Since a serious case of mumps as a child, which had triggered a brain infection and left him e!ectively deaf without his hearing aids, Marino’s health had been fragile. A heart specialist ran further tests and told Marino that it looked as if he might have Hodgkin’s lymphoma.
“I was in a state of shock,” Marino said. “When I told Jimmy and Sam, I could see the look of dread on their faces. It was like their faces were saying, ‘We’re screwed.’
They had encouraging words, and maybe they really were concerned about me. But they were also concerned about how to deal with the ongoing fraud.”
In June, Dan Marino’s diagnosis of cancer was con"rmed. He began a course of chemotherapy. Marino’s mother, whom he still lived with, was also su!ering from cancer. For the next six months, Marino came to Bayou only occasionally. This left Israel and Marquez alone together, apart from the small support sta!. Months of cascading disaster ensued—poor trades, angry recriminations, drunken nights. But investors heard an entirely different story—one of hard work and triumph.
“The second quarter of 1999 for us can best be described as the thrill of victory, then the same old story,” Marquez and Israel wrote in a joint letter to investors in July. Stock prices were grossly overvalued, they said. The market was being dumbed down as the Internet enabled pajama-wearing halfwit day traders to run up prices. “So, once again we "nd ourselves trying to "nd value to trade long stocks and picking our spots to be short,” they wrote. “Oh yes, we were able to post a second quarter gain of 12.45%, bringing our year to date to +19.56%.”
Word of Bayou’s success was beginning to spread to the higher reaches of the money management universe. Even in the booming hedge fund industry, the steadiness of their returns stood out. First Boston and Tremont Advisers began an index of the leading hedge funds and Bayou was included, a fantastic marketing coup. “We are de"nitely the smallest fund in the index which is all the more #attering to us,” Israel wrote to Bayou’s members. “We have undergone an intense amount of scrutiny for over two years to ful"ll the criteria of inclusion. We share the same vision of steady above average returns in any market condition as you do. As I have said to you, we win with grace and lose with integrity.”
But the reality was the polar opposite. Bayou continued to lose money. Marquez and Israel had countless excuses for their failure. Marquez complained about not having enough capital to make his strategies pay o!—or “muscle,” as he put it. Both complained about the ineptitude of their growing sta!. The traders said they didn’t have the right equipment. Or the market was wrong. Blame was pointed in all directions—except at themselves.
By the end of 1999, the S&P was up an epic 21 percent. Bayou had actually managed to make money. Precisely how much wasn’t clear, as it had become di$cult to truly follow the fund’s performance—even for Marino. The real number didn’t matter—not when results could be inve
nted. Israel and Marquez weren’t going to let the fund drift along with mediocre results. They had egos to sate. In their version of events, that year the fund beat the market soundly, providing an ROR—rate of return—of 33 percent.
“Jimmy and Sam couldn’t control themselves,” Marino said. “The actual number was half that. Jimmy and Sam should have managed it better. If they’d claimed we made 12
percent or 15 percent for the year, the extra money we’d actually made could have been put towards solving the problem. But they didn’t. When they had a good month and made money they used that as the performance number. When they had a bad month, they used a made-up number. They claimed it had to be done because they were getting feedback from clients about performance. I stopped tracking the published numbers against the real numbers. It made me sick to my stomach.”
Late one afternoon, Israel was sitting in the trading room when he felt Marquez staring at him. Looking up from his computer, he saw Marquez watching him with an air of sorrow. Sam knew that Marquez was seeing a therapist, receiving treatment for the sense of dread and helplessness that was overwhelming his life. Marquez said he felt sympathy for Israel. Sam was more than a decade younger than Marquez, with two young children and a whole life in front of him. Now Sam’s entire future was in jeopardy.
“I knew I was fucked if Bayou blew up,” Marquez said. “But now you’re fucked too.”
“What do you mean?” Israel asked.
“You can’t get another job either now,” said Marquez. “You’re just as fucked as I am.”
“Fuck you,” Israel said, anger rising. “I cannot believe you just said that. You were the one who got us in this situation. It’s your idiot trades that got us in the mess. It was your idea to change the numbers. It’s all your fault.”